A defining characteristic of racketeering and money laundering is concealing illegal business within some legal business. John Hempton’s recent blog described his visits and experience with #Herbalife Nutrition Clubs in tiny markets by revenue, telling us they are not illegal (except a few minor exaggerated medical claims; which I understand his point… those claims are understandable in the context of real weight loss). Nonetheless, he would have us believe these few tiny markets and Clubs are typical of the whole Herbalife Club model and Herbalife as a whole is not an illegal enterprise. He noticeably fails to point out that the overwhelming majority of Herbalife Clubs are in Latin/South America, Mexico and heavily Latino U.S. communities (approx. 50,000 Clubs in those overwhelmingly poor areas) versus less than 1,000 total Clubs (less than 2%) in the countries Hempton visited. Herbalife trumpets/promotes this purportedly “legal” portion of their business in order to give credibility to the whole. Criminals have been doing that for… well, for as long as they’ve been committing crimes.

Among other bad things, Herbalife is running a 50,000 Club fraud racket in the poorest World Bank countries and Hempton is spouting off about the wonderful shake bars he’s visited in a handful of tiny markets and telling us the whole company must be fine. In the infamous words of Dan Loeb… it’s preposterous.

I have 7 Nutrition Clubs in my small heavily Latino working class community on eastern Long Island, New York. The patrons of these Herbalife “Club 100” Clubs are EXACTLY as Christine Richard described… they go “to consume” (a seemingly benign response for native Spanish speakers to a company sponsored survey question… if the survey is not designed to probe for the truth.) The Clubs are recruiting and training venues and therefore they are frauds.

Hempton said he visited Clubs in 7 countries/cities (Miami, Sydney, Malaysia, China, Cambodia, Thailand, Israel), but excluding Miami, they collectively have less than 1,000 Clubs (maybe 2% of the total). He then draws a glaring contrast to the heavily Spanish Club 100 programs (referenced by Ackman in the U.S. communities and by Christine Richard in Latin/South America and Mexico)…. and concludes Herbalife is not a pyramid scheme because of his experience “on the ground”. He may be on the ground, but his head is in the clouds.

Latin/South America, Mexico and Latino communities in the U.S. represent approximately 50,000 Clubs, almost exclusively operating the Club 100 model and are the dominant driver of revenue and profits for the Herbalife Club segment.

By managements own admission, and their public statements, the vast majority of Nutrition Clubs failed within a year when the owner was soliciting true retail customers. Converting the Clubs to recruiting and training venues was the solution to a multi-fold problem; it drove product volume through the clubs (money; revenue), provided access to a lower socio-economic target market (new market, the “fortune at the Bottom of the Pyramid”), and gave the illusion of retail customers (criminal defense).

The FTC vs Futurenet is one reason Herbalife’s Nutrition Club model is illegal. The Court’s Final Order with respect to distributor training said: “Compensation related to recruitment is any form of compensation that is conditioned upon, derived from or related to recruitment of new persons to any business opportunity involving any multi-level marketing program. This term includes, but is not limited to, compensation paid or provided to participants in a multi-level marketing program as a result of or related to any type of training provided to either new or existing participants in a multi-level marketing program.” (emphasis added) Nutrition Club participants striving up the pyramid, who recruit their friends and family in support of their efforts, would not be there “to consume” (as Christine Richard quoted patrons, and as I know the same to be true) were it not for their training.

Club 100 advancement in the program is conditioned upon, derived from and related to bringing friends and family to the Club to drink shakes the participant prepares as part of their training; it is all part of “the Club 100 success system”… all of that runs afoul the Futurenet Court with respect to compensation related to recruitment.

You cannot look at individual Clubs or a tiny segment of Clubs, as Hempton does, and draw a conclusion about the whole. You must look at a much larger segment. Frauds, and pyramid schemes in particular, are masterful at diverting your attention to the outlier. It’s a common fraud tactic, diverting your attention away from what would otherwise be obvious. The vast majority of Herbalife Clubs are recruiting and training related venues. Management admitted… when they tried to build Clubs straight, virtually all failed. So they went to the TRAINING model! The Futurenet Court said any product sales conditioned upon, derived from or related to training is NOT RETAIL.

Hempton says Christine Richard suggested a huge number of people must be drinking 5-7 protein shakes per day which is not just conscripted consumption but forced consumption to the point of vomiting, in order to get to her numbers. It may have made for funny reading, but what Christine accurately described, and what I’ve know first hand as well, is Club(s) occupied by “students in training” bringing 3-5-10 friends and family who are “consuming” as part of a conscripted program to help their family member/friends move up the “ladder of success”. And by the way… many of these people may or may not want to lose weight too. But the primary reason they joined and go to the Club, is in support of their family/friend/student-in-training. Without the recruiting and training, sales of product would plummet. Period.

A word about Sales Leaders. In round numbers from the 2014 Statement of Average Gross Compensation, Herbalife says it pays out 72,000 “independent” Sales Leaders an average $5,500 per year or $400 million. Michael Johnson makes this sound so attractive, “about $500 per month part time income. That’s real money in these tough economic times.” But Johnson is a masterful liar and deceiver.

Herbalife includes in the Statement of Average Gross Compensation a tiny group (2.2% of participants eligible to receive payments) who earn virtually all the money, are the mega-recruiters (not retailers and not independent of Herbalife) and whose business model bears little resemblance to what they are pitching the audience/targets/recruits. Herbalife also excludes a very large group (about 37.5% of participants eligible to receive payments) that earn nothing. The result of this charade is to deceive “business opportunity” seekers about (1) the probabilities of success (they skew the numbers) and (2) the pathway to success (they make it look like retailing is the successful, when in fact, it is recruiting).

In order to mitigate this deception, 3 things should change in any Statement of Average Gross Compensation:

(1) Exclude the Top Recruiters income… the equivalent of Founders, Chairman, Presidents/GET Team etc… in the case of Herbalife, that’s 2.2% or 2,628 member/participants eligible to receive payments. It takes an average of 7 years to get to Presidents Team and these mega recruiters distort the disclosure statement which is intended for new recruits who are evaluating the business opportunity. Shouldn’t they be told what they can reasonably expect to earn “retailing” in the next 1-2-3 years, and not have it distorted by the lopsided income of 7,10,20,30 year senior mega recruiters? ;

(2) If you’re qualified and eligible as a Sales Leader you get included in the calculation, even if you haven’t added a single downline or earned a nickel. Herbalife had about 45,000 Sales Leaders who earned $0… so of course they exclude them;

(3) If you’re qualified/eligible to receive payments, you get included in the calculation. Period. In 2014 Herbalife had 2,966 Non-Sales Leaders with a downline, 1,821 made an average $48 and 1,156 made $0… Herbalife excluded them all. How convenient.)

Recasting Herbalife’s 2014 U.S. Statement of Average Gross Compensation looks like this:

Members

% of Total

Avg Gross Pmts

2,209

1.9%

$15,393

2,858

2.4%

$7,060

12,483

10.7%

$2,242

43,214

36.9%

$288

56,428

48.2%

$0

117,192

100.0%

$807

The Average Gross Compensation is really more like $807 ANNUALLY (not $5,500)

95%+ are spinning their wheels, losing money, time and reputation after considering the cost of becoming a Sales Leader and running their business.

85% make less than $300 per year, gross. Nearly 50% make $0.

Herbalife would have us believe (by faith alone) that ALL these people are out there successfully retailing their product to a vast network of millions of unknown and unproven consumers. Again, in the infamous words of Dan Loeb, that is simply preposterous. And besides, the burden of proof (of end consumers) is upon the company Herbalife, NOT the government or anyone else. Yet Herbalife claims this information is not material.

The true Business Opportunity is… Herbalife and co-conspirator Top Recruiters are fleecing new recruits for hundreds of millions of dollars every single year.

In addition to (1) (2) (3) above, The Statement of Average Gross Compensation should disclose the 1, 2, 3, 4 and 5 year Member average income (and must include everyone qualified/eligible to receive payments of any kind.) Basically, tell new recruits: if you join as a Sales Leader, this is what you can expect to make in the 1st, 2nd, 3rd, 4th and 5th year based upon the most recent recruits (and disclose how many quit!)

In the blog referenced above, John Hempton describes President’s Team members as company recruiters (“they are keen to recruit you and get you to do the same”), although he’s quick to point out they are “independent contractors”, which would be laughable if it wasn’t illegal and harmful in its conspiracy and racketeering. Hempton further describes Chairman’s and Founder’s level as nearly untouchable. I agree.

Let’s be clear about something, Top Recruiters are NOT independent consultants. That, too, is preposterous. They are hired guns for Herbalife. They are in cahoots with Herbalife management in perpetrating this fraud. They are as independent of each other as Mafia Bosses (Michael Johnson & Team), Underbosses (Founder/Chairman level) and Capos (President’s Team) in a crime family. Herbalife/Management is La Cosa Nostra (The Commission with Don Michael Johnson), and the Founders/Chairman run “families” and the President Team run “crews” that have myriad ways of separating aspirational and hopeful human beings from their money.

For an otherwise intelligent guy, John Hempton has been duped by a pyramid scheme. That is understandable. My brother is an extremely intelligent surgeon and was the victim of Equinox in the mid-1990s. I told my brother it was a pyramid scheme. He vehemently defended the company, it’s products and mission… right up until the Government shut it down and put the executives in prison. Like value investing, in my experience, people either understand it right away or they never seem to understand it at all. Rarely do they come around slowly. The worst part is, the fraudsters are great at spotting a credible outsider to promote their fraud.

Where do we go from here?

Here’s an interesting scenario: The FTC uses their Civil Investigative Demand (CIDs) in conjunction with the more recent Dept. Justice inquiries/subpoenas of Top Recruiters and Herbalife and the outcome is a multi-jurisdiction (FTC, DOJ, SEC and multiple State AGs) criminal case for Conspiracy, Racketeering, Money Laundering and Fraud. (And the DOJ Office of Foreign Litigation gets involved to seize foreign assets, issue executive arrest warrants, just like FTC v Fortuna, which was a 60 country pyramid fraud, until all foreign assets are returned to U.S. custody.)

Few people thought SAC Capital, the largest, most successful and influential hedge fund in the world would be stopped for its criminal activity… despite persistent rumors and attempts by other prosecutors. SAC had a stable of former federal prosecutors on staff and a multi million dollar annual compliance budget. Then one day, seemingly out of the blue, Preet Bharara held a press conference and declared SAC Capital a long dated breeding ground for criminal activity; recruiting, incentivizing and rewarding criminal behavior; turning a blind eye toward it; and paying lip service to enforcing compliance with the law…and Preet Bharara said “today it stops.”

I’m still waiting for the day a true leader in our government, with a moral compass and armed with the facts, (Preet Bharara, James Comey, Edith Ramirez, Mary Jo White, Eric Schneiderman, Lisa Madigan, Kamala Harris) has the backbone to stand up to the criminals running and promoting Herbalife, who prey upon the hopes and aspirations of other human beings in the U.S. and around the world.